Average incomes plunged by more than seven per cent in real terms in the last two years, in what economists said amounted to the biggest knock to living standards since the Second World War.

Meanwhile almost a million people – including 100,000 pensioners and 300,000 children - fell below the poverty line while families in which mothers stay at home were also among the worst hit.

And in a blow to the Work and Pensions Secretary Iain Duncan Smith’s drive to “make work pay” there was a sharp increase in the number of children whose parents have jobs classed as living in poverty.

Overall two thirds of children officially recognised as living in poverty are now from households in which least one parent works.

But the figures, published by the Department of Work and Pensions (DWP), reopened the row about whether child poverty targets are meaningless as one widely used official measure suggested there was no increase in relative poverty at all – mainly because incomes have fallen across the board.

Mr Duncan Smith insisted that the figures showed that the Coalition was succeeding in stopping the poorest falling even further behind but accepted that there was a “real challenge”.

But charities argued that the findings showed that low wages rather than unemployment are now the biggest problem facing families in the UK.

Overall the figures showed that a freeze on wages or a series of below-inflation pay rises and steep increases in fuel and food prices over the last few years have effectively wiped out improvements in living standards in the first decade of the 21st century.

Average household incomes dropped by three per cent in real terms between 2011 and 2012, the second year in a row in which they have fallen, taking them to levels not seen since 2001.

The average annual household income now stands at just over £22,000 before housing costs or major expenses such as childcare.

It follows a report by the Institute for Fiscal Studies this week which showed that workers have suffered “unprecedented” wage cuts since the 2008 financial crisis but, unlike in previous recessions, kept their jobs.

“This is unprecedented in post war recessions,” said Prof John Van Reenen, director of Centre of Economic Performance at the London School of Economics.

“There have been a lot more pay freezes than in the 1970s, 1980s and 1990s recessions and so price inflation has eroded real pay.

“Weaker unions and more pressure on unemployed to find jobs have made wages more flexible.”

Others said the relatively low unemployment masked a growing problem of “in-work poverty”.

Katie Schmuecker, policy manager at Joseph Rowntree Foundation said: “The clock has been turned back for family incomes, and gains from the boom years have disappeared – we’re in danger of seeing a lost decade for living standards.

“Stagnant wages, underemployment, rising costs and cuts in support for families have combined to reduce household incomes.

“That has effects for us all, but is felt most keenly by those who had little to start with.

“It means we have a relentless rise of people working but living below the breadline.”

Overall the number of people living in so-called “relative poverty” – based on how poor they are in comparison with the average – remained unchanged at 16 per cent last year.

But so-called “absolute poverty” – which uses a fixed figure for comparisons – soared by 900,000 last year, a third of them children.

And the number of people living in families with a simgle breadwinner living in poverty jumped by 200,000 in the past year to 800,000.

Some 3.8 million children are now living in absolute poverty in the UK, 2.4 million of them in working households.

Analysis by the Children’s Society suggested that the “entire” increase in child poverty came from those in working households.

Matthew Reed, the charity’s chief executive, said: “It is shameful that, as one of the richest countries in the world, child poverty is being allowed to increase.”

Alison Garnham, chief Executive of Child Poverty Action Group, said: “The truth is that for a growing number of families work isn’t working – the promise that work would be a route out of poverty has not been kept as wages stagnate and spending cuts have hurt low income working families.”

A spokesman for the DWP insisted that the implementation of the new Universal Credit would make three million households better off and finally ensure people are better off in work.

Mr Duncan Smith said: “We have successfully protected the poorest from falling behind and seen a reduction of 100,000 children in workless poor families.

“Our welfare reform programme will further increase work incentives.”

But he added: “Today's figures underline the need for better measures of child poverty that are not so heavily dependent on where we draw the poverty line.

“Our new approach with wider measures is not designed to hide the scale of child poverty in this country, but to make clear the real challenge we face so we can start dealing with it properly.”